Download Client Letter 2Q 2015

LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
will be needed over the next 3 years, until end2018, Christian Lagarde, its managing
director, has also stated that any Greek rescue
will not be viable without debt relief.2
Client Newsletter for the period ended
30 June 2015
1.
2.
3.
4.
Foreword
Market Commentary
Portfolio Review
Stock Market Tycoon
Although Greece only accounts for 2% of
European GDP, second-order effects are
important: Portugal, Ireland and Spain all
implemented painful austerity measures in
exchange for the financial aid that they
received. Ireland exited its bailout in late
2013, followed by Spain in early 2014, then
Portugal in mid-2014.
1. Foreword
Fellow Investors,
Welcome to the Lighthouse
newsletter for June 2015.
Lighthouse Advisors Private Limited
Reg. No. 201212773E
10 Anson Road, #38-03 Unit A
International Plaza, Singapore 079903
www.lighthouse-advisors.com
Advisors
If Greece gets debt haircuts to help it survive,
it is only logical for Portugal, Ireland and
Spain to demand the same. In fact, they might
ask for bigger haircuts as a reward for good
behavior; otherwise, what would be the point
of suffering obediently if you could be like
Greece and get more help by behaving badly?
This newsletter follows the same format as
previous issues. The special topic for this issue
is Stock Market Tycoon.
2. Market Commentary
Germany, being the largest contributor to the
European Central Bank, would bear the brunt
of the haircuts. But the Germans have already
lived through 25 years of an extra “solidarity
tax” to pay for the rebuilding and integration
of East Germany, and they are still not done. It
remains to be seen if Chancellor Angela
Merkel can convince her compatriots to sign
up for another few decades of paying extra
taxes, this time to keep Europe afloat.
The big news of the last few months is
undoubtedly the economic collapse of Greece,
dubbed “Grexit” for the possibility that Greece
may leave the Eurozone.
In a referendum conducted on 5 July, 61% of
Greek voters said “no” to the aid package
proposed by creditors on June 25. The
consequences of the “no” vote soon became
apparent as Greek banks shut their doors to
avoid running out of cash, capital controls
were implemented, and ATM withdrawals
were limited to €60 per day. Spooked, Greek
Prime Minister Alexis Tsipras executed an
about-face and pushed through legislative
reforms even harsher than the package the
voters rejected1.
Currently, the earliest that Germans can retire
is 63, whereas until recent reforms many
Greeks could retire as early as age 55. So
Germans are working harder and retiring later,
so that Greeks can collect their pensions
earlier. Obviously, Greeks do not view things
the same way, especially when 45% of Greek
pensioners already receive monthly payments
that are below the official poverty line of
€6653, but the facts are what they are.
Still, not everyone thinks the new deal will be
enough. The IMF, for one, believes that
further debt relief is necessary. While the IMF
has estimated that an additional €85bn of aid
2
IMF defends decision to go public on case for Greece
debt relief, Financial Times, 17 July 2015
1
The Troika Returns to Athens as Cowed Tsipras
Submis to Demands, Bloomberg Business News, 24
July 2015
3
A Greek paradox: many elderly are broke despite
costly pensions, Reuters, 16 July 2015
1
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
“We stand today at a crossroads: One path
leads to despair and utter hopelessness. The
other leads to total extinction. Let us hope we
have the wisdom to make the right choice.”
About 1,300 companies in Shanghai and
Shenzhen, comprising about 45% of all
listings, simply halted trading in their shares7,
citing “significant issues”, a term usually used
to refer to restructuring or major transactions.
Trading halts can last up to 3 months, so it is
possible they were used to sit out the sell-off.
- Woody Allen
In China, as your manager warned in the last
newsletter, the high valuations have come
home to roost. From mid-June through early
July, the stock markets went into freefall. Both
the Shanghai and Shenzhen indices fell more
than 20% from their peaks, entering official
bear market territory.
These stopgap measures seem to have
stemmed the bleeding for now: the benchmark
Shanghai Composite has bounced off a bottom
of about 3,500, while the Shenzhen Composite
has bottomed at about 1,900.
Volatility is extreme: about 80% of the
turnover in the Chinese stock market is
attributed to retail investors, and just as it can
be boosted to dizzy heights by unjustified
optimism, so can it be sold down in sudden
panic. Daily turnover is almost RMB 2 trillion,
so even if the pension funds and the
stockbrokers invested all their allotted money
at once, it would be consumed in less than half
a day’s trading. In other words, if the Chinese
people want out of the stock market, it is
going down, period.
Despite the numerous warnings from internal
and external observers alike, the speed of the
decline appeared to have caught the Chinese
Communist Party off-guard, with several rules
enacted to encourage more speculation, such
as allowing stockbrokers to issue short-term
bonds, and easing collateral rules on margin
financing4. Draft rules were unveiled to allow
pension funds to invest up to 30% of their
estimated RMB 2 trillion of assets into stocks,
and 21 stockbrokers set up a RMB 120 billion
fund to buy into the stock market.
Given the still-unhealthy valuations present in
the Shanghai and Shenzhen markets, the
Chinese government’s attempts to prop up the
markets are unlikely to end well. At best it
will allow some retail investors to exit, but it
will be essentially replacing such retail money
with public funds.
The China Securities Regulatory Commission
(CSRC) announced it would boost the capital
base of the government-backed margin finance
agency, China Securities Finance (CSF), from
RMB 24 billion to RMB 100 billion 5 . This
will let CSF to lend more money to
stockbrokers for margin financing, although
the stock market decline suggests that total
margin loans are likely to fall instead. Pension
funds were told that they could buy but not
sell shares. The CSRC even banned directors,
executives and substantial shareholders from
selling their shares for 6 months6.
While some may compare the Chinese
government’s efforts to stabilization funds
launched by other governments, such as Korea
(1990), Taiwan (2000) and Hong Kong
(1998), Hong Kong is the only case where the
stabilization fund is considered to have
succeeded. Furthermore, the Hong Kong fund
was buying at a time when the market was
depressed in the wake of the 1997 Asian
financial crisis. Buying low makes it a lot
easier to do well. Unfortunately, the Chinese
stock market is currently not depressed by any
reasonable measure.
4
China Intensifies Steps to End $3.2 Trillion Stock
Rout, Bloomberg News, 5 July 2015
5
China’s central bank to fund margin finance agency in
latest stock market bailout bid, South China Morning
Post, 5 July 2015
6
7
China Bans Stock Sales by Major Shareholders for 6
months, Bloomberg News, 8 July 2015
China stock market freezing up as sell-off gathers
pace, Reuters, 8 July 2015
2
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
Closer to home, the 1 Malaysia Development
Berhad (1MDB) saga is threatening to sink
Malaysian Prime Minister Najib Abdul Razak.
The Wall Street Journal obtained documents
that showed nearly US$700m had been
transferred into personal bank accounts in
Najib’s name 8 . The Journal also released
redacted versions of the documents online.
Najib has not denied the existence of the
accounts or the transfers, saying only that he
has “never taken funds for personal gain”,
which then begs the further question of who
the eventual recipients of the US$700m were.
cash cushion, has been a good bulwark against
the market swings in China. Your manager
continues the search for investment ideas amid
the changing tides of the stock market.
Malaysian business weekly The Edge also
published an exposé documenting how 1MDB
was defrauded of US$1.8bn 9 . Among the
transactions flagged was a US$700m transfer
to repay a non-existent loan. The money was
not even paid to the supposed lender
PetroSaudi Holdings, but instead to a company
controlled by Low Taek Jho, a friend of
Najib’s stepson. US$529m was later
transferred to a company owned by Low.
3. Portfolio Review
The next newsletter will be published for the
quarter ended 30 September 2015.
Benjamin Koh
Investment Manager
Lighthouse Advisors
27 July 2015
As at 30 June 2015, the Net Asset Value
(NAV) of the Fund was USD 100.99. Net of
all fees, the year-to-date return was 1.1%.
19 securities made up 82% of the Fund’s
holdings, with the balance in cash. A pie chart
is in Annex I, while NAV values are tabled in
Annex II.
New Investments
So far, the Malaysian authorities have arrested
various individuals, frozen some bank
accounts and even suspended the publishing
permit of The Edge, but the central figures in
the saga, Najib and Low, have remained
untouched. While many are calling for Najib
to resign, more jaded observers note that his
most outspoken critic, former Prime Minister
Mahathir
Mohamad,
survived
several
corruption scandals during his own 22-year
rule.
CIMC Enric is a manufacturer of metal tank
containers used for the storage and transport of
natural gas (50% of sales), chemicals (30%)
and liquid foods (20%). It is a subsidiary of
state-owned enterprise China International
Marine Containers.
The energy segment mainly serves the
liquefied natural gas (LNG) market. Demand
for LNG depends on the price spread against
diesel, and the current low oil prices have
reduced demand for LNG refueling station
infrastructure, tanker trucks and conversion
kits. Sales are expected to be flat for now.
The Fund made some modest investments into
Hong Kong during this period, so it was not
immune to the down draft. However, its asset
allocation, comprising a low weight in Hong
Kong, a larger weight in Singapore, plus a
The chemicals segment is considered to be
mature, but the Group has a 60% market share
world wide, which gives it important cost and
thus profitability advantages over the second
largest player, which has a 15-20% share.
8
Malaysia 1MDB Probe Says It Has Found Documents
Tied to Alleged Transfers to Prime Minister Najib,
Wall Street Journal, 4 July 2015
The liquid food segment grew significantly
after the acquisition of a German company,
Ziemann. Ziemann has 160 years of history
9
How Jho Low and PetroSaudi schemed to steal money
from the people of Malaysia via 1MDB, The Edge
Markets, 20 July 2015
3
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
and was successful in the brewery equipment
industry. It supplied China’s first brewery
plant under Tsingtao, in 1903. However, some
poor management decisions, coupled with the
global financial crisis, led to insolvency. The
Group acquired Ziemann along with key
employees, and has successfully parlayed it
into new contracts, notably for Constellation
Brands, where the “new” Ziemann was
awarded a contract to expand the Piedra
Negras plant in Mexico which had been built
by the “old” Ziemann.
Divestments
Historically, the Group has grown both
organically and via acquisition. The moderate
outlook is likely to drive acquisitions as
owners become more willing to sell out. In the
absence of major acquisitions, cash flow will
be strong: the company’s operations convert
about 2/3 of reported profits into free cash.
Sa Sa was sold due to a deterioration in the
business environment. The “Occupy Central”
protests in Hong Kong had already dented
consumer
confidence
among
Chinese
shoppers, and the last straw came when the
Chinese government stopped issuing multipleentry visas to Shenzhen residents visiting
Hong Kong. Instead, they could only once per
week. Whether this was to punish Hong Kong
for Occupy Central, or to appease Hong Kong
by reducing Chinese shopper traffic, or both,
the outcome was to eliminate the “day-tripper”
customer commuting into Hong Kong for
cosmetics, toiletries, and, yes, milk powder.
Chinese clients form about half of Sa Sa’s
sales, so this was devastating. Lower sales and
higher rents are a bad combination. Sa Sa was
divested immediately after the visa restrictions
were announced. Most of the shares were
acquired via in-specie subscriptions when the
Fund was launched. As a result, the cost base
was high, and the loss on divestment was
approximately 50%.
CITIC Telecom was sold as the stock had
appreciated substantially in recent months,
despite the forward picture getting worse. The
telecom hub business has not recovered as
margins continue to erode and call volume is
lost to VOIP providers such as Skype.
Meanwhile, in Macau the decline in visitor
numbers bodes poorly for CTM as roaming
revenues are a significant contributor to
profits. Gain on divestment was about 70%.
The shares were acquired at 14 times earnings,
at a yield of 2%.
Dongpeng
Holdings
is
a
Chinese
manufacturer of bathroom ceramic tiles.
Although Dongpeng is the largest player in
China by retail sales value, its market share is
less than 2%. The distribution network will be
a key advantage in gaining market share.
Currently, Dongpeng is present in over 600
cities, with nearly 2,000 retail stores. 74% of
sales are to 968 tier-one distributors, with the
balance sold directly to property developers,
preferred dealers and consumers via selfoperated retail outlets.
Although Dongpeng is indirectly exposed to
the real estate market, there is a time lag as
homeowners renovate their homes only after
taking possession, so changes in the real estate
market are moderated by the passage of time.
90% of sales are to first-time homeowners so
Dongpeng’s sales are tied to underlying
urbanization trends, rather than demand for
housing as an investment.
Other Significant Events
OUE proposed to sell its interest in One
Raffles Place to OUE Commercial REIT for
about S$1 billion. This is at a small discount
to the fair market value, so OUE will book a
small loss of about $0.02 per share on the
disposal. The proceeds will be used for
working capital. One Raffles Place was
already flagged as a pipeline deal when OUE
Commercial REIT was listed, so there were no
surprises when it was announced. The deal has
since been approved by shareholders.
The shares were bought for 8 times earnings,
with a 4% yield. In terms of EV/EBITDA, the
multiple was 3.3x.
4
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
If one is an accomplished investor, one may
very well choose to bet against the tycoon. For
example, Carl Icahn has publicly clashed with
William Ackman over Herbalife. Ackman has
a short position against Herbalife, while Carl
has a long position in Herbalife.
4. Stock Market Tycoon
In the classic computer game Railroad
Tycoon, the player tries to amass a fortune by
building and controlling a rail network.
Besides operating the railways by laying track,
building stations and buying trains, the player
can also use the stock market to sell bonds for
cash, or buy shares in their own corporation or
that of rivals. Takeovers are possible, allowing
the player to control rivals and raid their
treasuries for cash. Wealth is maximized when
the player makes shrewd decisions in both
operations and finance.
Who is right: Ackman or Icahn? While
professional investors do (or are supposed to
do) their own homework, many amateurs
choose to follow the “smart money”. But in
this case there is smart money on both sides of
the table. Both investors are billionaires who
earned much of their fortunes in the stock
market. On average, they have been right, but
here they cannot both be correct. The simplest
– and safest – answer in this case is to bet on
neither side and watch from the sidelines.
Of course, Railroad Tycoon is at best a
business simulation, but many real-life
tycoons have accumulated great wealth with
similar tactics. In business, tycoons are
aggressive competitors fighting to protect their
market share and maximize profits. In the
stock market, they look to sell when assets are
overpriced, and buy when they see a bargain.
More common, and far easier, are cases where
there is a tycoon on only one side of the table.
Almost always, the right thing to do is to
decline the deal with the tycoon. Tycoons do
deals to make money. That means they are
trying to buy low and sell high. If the tycoon is
right, those on the other side will be selling
low and buying high. While tycoons do make
mistakes, as a group, their accumulated wealth
suggests that on balance they are correct.
Most businessmen will have neither the
appetite nor the opportunity to take on a
tycoon in business. But most investors will
encounter a tycoon or two in the stock market
at some point.
"Well, that's the news from Lake Wobegon,
where all the women are strong, all the men
are good looking, and all the children are
above average."
A description of some notable tycoon deals in
Asia follows.
In 2001, Quek Leng Chan’s Guoco Group
sold Dao Heng Bank to DBS Bank. DBS
eventually paid S$10 billion or about 3 times
book value for Dao Heng. In 2005, DBS wrote
off S$1.1 billion against the investment, and in
2010 it wrote off another S$1 billion. Total
loss to DBS shareholders: S$2.1 billion.
- Garrison Keillor, News from Lake Wobegon
It is a well-known phenomenon of human
psychology that most people think they are
above average. But by definition, most people
are average. True, sometimes the person in
question is indeed above average, and then
they may have an edge against the persons
they interact with, who are, on average,
merely average.
In April 2003, Ananda Krishnan privatized
offshore vessel operator Bumi Armada for
RM 7 per share, valuing the whole company at
RM 441m. Bumi Armada reported earnings of
RM 1.02 per share for 2002, so the shares
were arguably cheap at about 7 times earnings.
But tycoons are assuredly not average.
Otherwise, they would have merely an
“average” net worth. So what is one to do
against such an “above average” opponent?
Minority shareholders were essentially forced
out: Krishnan had acquired a stake of over
70%, and if he was able to cause the free float
5
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
out RM 3.7 billion in dividends, so those
shares have already covered their cost more
than 3 times over. And Krishnan still owns the
businesses in India and Indonesia. Maxis
shares closed at RM 6.37 on 30 June 2015,
valuing the entire company at RM 47 billion,
and Krishnan’s 70% stake at RM 33 billion.
to go below the 25% minimum for 6 months,
the stock exchange would automatically delist
the company. Minority shareholders risked
being trapped in a private company if they did
not sell to Krishnan.
In July 2011, Bumi Armada went public
again in Malaysia. It raised RM 2.7 billion by
selling 879m shares at RM 3.03 per share,
valuing the company at RM 8.8 billion, or
over 20 times 2010 earnings. The stock
subsequently slumped when oil prices
collapsed. Whether or not Krishnan foresaw it,
the fact is that he bought low and sold high.
On 30 June 2015 Bumi Armada shares closed
at RM 1.14, marking the capital loss to the
investing public at RM 1.67 billion.
In February 2011, Li Ka Shing’s Hutchison
Ports went public in Singapore, selling
3.8 billion units at US$1.01 each. On 30 June
2015 it closed at US$0.63 per share. Capital
loss to the investing public: US$1.44 billion.
In April 2011, Li Ka Shing’s Hui Xian REIT
went public in Hong Kong, selling 2 billion
units at RMB 5.24 each. On 30 June 2015 it
closed at RMB 3.48 per share. Capital loss to
the investing public: RMB 3.52 billion.
In May 2007, Ananda Krishnan privatized
telecommunications service provider Maxis
Communications, paying RM 17.4 billion for
the 53% stake he did not own, valuing the
entire company at RM 33 billion. Maxis
operated in Malaysia (100% owned), India
(74%) and Indonesia (95%). In November
2009, Maxis Berhad re-listed in Malaysia, but
this time it held only the Malaysian business.
The company did not issue new shares.
Instead, Krishnan sold 2.25 billion shares
representing a 30% stake for RM 11 billion,
valuing the company at RM 39 billion.
In April 2014, Robert Kuok’s Pacific
Offshore Services Holdings (POSH) went
public in Singapore, selling 338m shares at
S$1.15 each. On 30 June 2015 it closed at
S$0.435 per share. Capital loss to the investing
public: S$242m.
These deals were all perfectly legal, but
clearly, the benefits were not equally
distributed. In each case, the tycoon bought
low, sold high, or did both. The investing
public on the other side of the transaction did
the opposite, and so by definition did not fare
too well, to say the least.
For a net cost of RM 6.4 billion, Ananda
Krishnan had increased his effective
ownership of the Malaysian business from
47% to 70%, and his effective ownership of
the businesses in India and Indonesia from
35% and 45% respectively to 100% each. But
that is not all. For 2007, 2008 and 2009,
Krishnan had Maxis pay him dividends of
RM 2.7 billion, RM 720m and RM 2.6 billion.
He gave back RM 705m in the restructuring
prior to the re-listing, so on a net basis he
received RM 5.3 billion. Thus, the whole
privatization-and-relisting exercise actually
cost Krishnan only RM 1.1 billion.
Just because a deal is done on a “willing
buyer, willing seller” basis does not mean that
the benefits are shared equally. If one is
dealing with a tycoon, the odds are high that
the tycoon will receive the bulk of the value.
“Neither a borrower nor a lender be”
- Polonius, Hamlet
Perhaps the stock market equivalent with
respect to tycoons is “neither a buyer nor a
seller be”.
In the 5-plus years since the IPO, the extra
23% of Maxis that Krishnan bought has paid
End 
6
Updated 27 July 2015
LIGHTHOUSE ADVISORS
Keeping Your Capital Safe
Annex I
Fund Holdings as of 30 Jun 2015
ARA Asset Mgt
Chow Sang Sang
2%
3%
CIMC Enric
4%
Cash Before Fees
18%
Clear Media
4%
Dongpeng
5%
Sunningdale Tech
3%
Dynam Japan
2%
Frasers Centrepoint
7%
Strac o
10%
Greatview As eptic
5%
SBS Transit
4%
k1 Ventures
6%
Sarine
2%
Pic o Far East
4%
Pacific Textiles
OUE
6% Overseas Education
5%
4%
Luk Fook
3%
Nera Telec om
4%
Annex II
2013
2014
2015
Jan
Feb
Mar
Apr
May
Jun
Jul
99.15
97.97
101.78
98.16
99.80
97.74
101.84
103.80
105.45
103.69
106.57
100.99
109.05
Aug
100.00
108.58
Sep
100.86
103.60
Oct
102.24
103.91
Nov
102.63
101.87
Dec
102.93
99.94
YTD
+2.9%
-2.9%
+1.1%
7
Updated 27 July 2015